Developed market sovereign bond issuers face declining demand from one of their core investor bases, according to the results of a survey conducted by OMFIF. Faced with a lower-for-longer yield environment, many global public investors are turning to riskier asset classes to maintain or increase returns, the survey found.
These investors – central bank reserve managers, public pension funds and sovereign funds – typically construct risk-averse portfolios. Their reduced appetite for higher-rated sovereign bonds will concern debt management offices hoping for a return to more normal markets following a sustained and unprecedented period of direct central bank intervention. It also calls into question the overall demand from investors globally for their bonds.
The survey – which aggregates future asset allocation strategies from over 100 leading investors – forms part of OMFIF’s annual Global Public Investor report. A snapshot of its findings was revealed during a session of the ‘Future of European sovereign debt’ event hosted by OMFIF’s Sovereign Debt Institute on 8 June, which included speakers from the Next Generation European Union fund and DMOs from Germany, Italy, Portugal and the UK.
Over 30% of the investors surveyed plan to reduce their overall allocations to government debt over the next two years, with 6% planning to do so significantly. Corporate bonds, equities, real estate and infrastructure all saw significant net increases in allocations.
A deeper dive into their expected government bond portfolios shows a reweighting towards higher-yielding sovereign debt, as Figure 1 shows.
Close to 30% of investors plan to reduce their holdings of developed market sovereign debt, and as a group they will be net sellers of AAA-rated government bonds. Some investors plan to move along the risk spectrum: more than 20% expect to increase holdings of emerging market sovereign debt. Others are planning to marginally improve yields through buying lower-rated investment grade government debt or supranational and agency bonds – the latter, perhaps, in anticipation of future sovereign downgrades.
June is likely to see the debut bond issue from the EU’s Next Generation fund, which plans to raise €750bn from capital markets to finance the union’s response to Covid-19 and which could transform bond markets in Europe and beyond.
OMFIF asked its investor group whether they expected the new debt instruments to become a permanent feature of their reserves portfolio in the future. Around 70% of central bank reserve managers globally anticipate that will happen – a figure which one might have expected to be higher, but may have something to do with the fact that the Next Generation fund’s issuance mandate currently only runs to 2026. Among global public pension funds the figure was substantially lower at just over 40%.
On a regional basis, the attitude towards the Next Generation bonds’ potential status as part of reserves is mixed, as Figure 2 shows. The majority of European funds expect them to be part of the reserves portfolio, but more than a quarter of funds on the continent do not. There is likely to be strong demand from emerging markets, with GPIs in Africa, Latin America and the Middle East all bullish.
But there is more scepticism among Asian investors. Less than 40% of public funds in the region – many of them among the most powerful in the world – anticipate that Next Generation bonds will become part of their reserve portfolios in the future.
The strength of demand for green sovereign bonds was demonstrated in March when the Republic of Italy launched its debut Green BTP, which generated an order book of around €80bn for a deal sized at €8.5bn. Demand for such assets will continue to grow, according to the results of the OMFIF survey (see Figure 3).
Already more than 90% of central bank reserve managers globally have invested in green bonds, compared to just 60% of public pension funds. Of the central bank respondents, around 65% plan to increase their green bond allocations in the next 12-24 months. They also expect to add to their sustainable holdings in other asset classes, such as green equities and sustainable exchange traded funds.
Clive Horwood is Managing Editor and Deputy Chief Executive Officer at OMFIF.